The
Short Strangle is a simple adjustment to the Short Straddle to improve the
probability of a profitable trade by widening the strikes and therefore the
break even points. Instead of selling at-the-money options, you sell
out-of-the-money calls and puts, which means a lower net credit but typically
wider break even points.

The
Short Strangle is precisely the opposite of a (Long) Strangle. We short out-of-the-money
puts and calls with a short time to expiration (one month or less) in order to
pick up income. Because you are short options, time decay works for you, so you
only select short-term expiration dates.

Also
you are exposed to potentially unlimited risk, which is another reason for
making this a short-term strategy. Its worth reemphasizing that the problem is
that

you
could be successful at it for months, picking up modest income over and over

again,
and then all at once one big loss will wipe out years worth of gains.

Each
leg of the trade has uncapped downside. If the stock starts going ballistic in

either
direction, then your position is precarious to say the least. If the stock
remains rangebound, then you will make a limited profit. If the stock gaps in
either direction, you are history!

Note:
you would never trade this strategy right before a news event like an earnings
report. You certainly would not want any nasty surprises to be lurking around
the corner.

Market
Opinion

Directional
neutral.

P/L

When
To Use

Use
this strategy when you anticipate no movement in the stock and are looking for
income.

Example

XXXX
is trading at $25.37 on May 14, 2011.

Sell
June 2011 $22.50 strike put for $0.35.

Sell
June 2011 $27.50 strike call for $0.65.

Net
credit: premiums sold = $1.00.

Benefit

The
benefit of this strategy is the possibility of receiving a high yield income on
a rangebound stock.

Risk
vs. Reward

The
risk is unlimited. The reward is limited to the net credit you receive from
selling puts and calls.

Net
Upside

Net
credit received.

Net
Downside

Uncapped.

Break
Even Point

Break
even up: net credit received.

Break
even down: lower strike minus net credit.

Effect
Of Volatility

Negative
when your position is profitable, and positive when it is not profitable.

Effect
Of Time Decay

Positive.
You are in short options, so you want to be out of them as soon as possible.

Alternatives
Before Expiration

To
stem a loss, buy back the option if the stock breaks through resistance or
support.

Or
buy back both options if you are in profit, but you think news could change
market opinion about the stock.

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